Measuring the Money Supply

Money is only money if it's liquid: usable to buy things right now without converting it first. Cash in your pocket and funds in a checking account both qualify, so they belong to M1, the narrowest measure of the money supply. Checking money counts because you can write a check or swipe a debit card immediately. A bond does not count as money, even though it is valuable, because you have to sell it first and wait to get cash in hand. That conversion step is what separates money from other assets.

M2 starts with M1 and adds near-monies: savings deposits, small time deposits, and money market mutual funds. These are assets people treat almost like money, but they need one extra step, like a transfer or a withdrawal, before they can be spent. So M2 is always bigger than M1, and M1 is always fully included inside it. Moving funds between these categories does not create or destroy money; it just reshuffles which measure counts it. If someone shifts 500 dollars from savings to checking, M1 rises by 500 because checking deposits grew, but M2 stays exactly the same, since the 500 dollars simply moved from one piece of M2 to another.

This distinction matters once the unit turns to the money market and interest rates, because the supply curve there is built from M1-type balances that households and firms actually hold for transactions. Knowing precisely what counts as money, and what doesn't, keeps that next model grounded.